How the U.S. Tax Reform affect Offshore Entities

With the recently introduced U.S. tax reform, the lawmakers also added a new offshore tax, which is designed to tackle the issue coming from the intangible income many corporations and partnerships stack abroad. It is called “Global Intangible Low-Taxed Income” (GILTI) and as its name suggests it will be affected by the law no matter, which country outside of the U.S. it is generated in.

This new offshore tax will apply to many types of income, including royalties, licensing and patents. Giants like Apple have been benefiting from loopholes generating them millions if not billions of these types of intellectual property income before the offshore tax was introduced with the U.S. tax reform.

The new law is set to affect not only corporations but also not publicly traded partnerships, service providing firms with offices abroad and companies who use foreign plants, equipment and inventory.

The intention behind GILTI is to encourage big American companies to hold their intellectual properties in the U.S. rather than offshore. At the moment, the most preferred location for the big players in Ireland.

What’s the Deal for Corporations?

The way corporations benefit from the U.S. tax reform is by having their corporate tax cut to 21% from the previous 35%. That’s sound just fantastic for the CEOs and shareholders, however, now that the tax rate is lower, it will apply on all generated income, even from abroad without a right for deferral. To make the contrast, up until now, foreign earned income was also taxable, but not actually due until brought into the U.S. After the U.S. tax reform corporations will have to pay tax on all of their foreign earned income even if it doesn’t come back to the country. Lawmakers expect to collect taxes on over $3 trillion sitting offshore.

Here’s the good news, at least for the large corporations. There will be many deductions available to most big organizations with foreign-generated income, which will make the 21% corporate tax rate, effectively, 10.5% until Protected content . After that, there will be an increase in the rate up to a little over 13%. This is a huge tax relief for corporations and it means they may be able to fully avoid GILTI until after Protected content .

The short answer is no and here comes the explanation. The U.S. tax reform was quite generous to partnerships and the pass-through business entities by giving them a 20% tax cut. This, however, only applies to their domestic income. As such structures, organizations like these do not pay taxes themselves but pass the income and tax obligations to their owner, who is then taxed on an individual rate. The highest individual tax rate after the U.S. tax reform is 37%, which is way above 21%, applicable to corporations.

In reality, partnerships won’t also be able to qualify for the deductions so if a corporation pays $10.50 on each $100 as offshore tax, partnerships and pass-throughs, in many cases, will have to pay as much as $37.

A solution to this may be a partnership going public. Tax experts claim that publicly traded partnerships and pass-through organizations will be able to benefit from the GILTI deductions and reduce their taxes.

Who Will Be Most Affected by GILTI?

GILTI is expected to affect most businesses who generate a good amount of their income through intellectual properties and not so many manufacturers and fabrics.

Another sector may be heavily affected by the GILTI and the “Orwellian” offshore tax. That’s banks. Although most of them are structured as corporations, therefore benefiting from mild tax rates and deductions, they will have to pay more in taxes now than before the U.S. tax return. This is because in Protected content will no longer be able to defer foreign-generated income affected by GILTI.

It seems that while there were serious concerns about U.S. tax reform provision of too many loopholes for pass-through organizations trading on American soil, those who generate income abroad have been heavily disadvantaged by the offshore tax and the introduction of GILTI. Corporations, on the other hand, enjoy a full-blown tax relief.